Digital Organics (DO) has the opportunity to invest $0.93 million now ( t = 0) a
ID: 2645809 • Letter: D
Question
Digital Organics (DO) has the opportunity to invest $0.93 million now (t = 0) and expects after-tax returns of $530,000 in t = 1 and $630,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 14% with all-equity financing, the borrowing rate is 10%, and DO will borrow $230,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of $0.25 per dollar of interest paid. Calculate the project
Digital Organics (DO) has the opportunity to invest $0.93 million now (t = 0) and expects after-tax returns of $530,000 in t = 1 and $630,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 14% with all-equity financing, the borrowing rate is 10%, and DO will borrow $230,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of $0.25 per dollar of interest paid. Calculate the project
Explanation / Answer
Project APV = Net Present value of the returns of the project financed through equity + Net Present value of benefits through debt financing
Net Present value of the returns of the project financed through equity
930000 - 530000/(1+14%)^1-630000/(1+14%)^2
930000- 464912.28 - 484764.54
= - 19676.82
Net Present value of benefits through debt financing
Interest rate has been charged according to the principle amount due to be paid each year :
Ist Installment schedule
Second Installment schedule
Net Present value of benefits through debt financing
230000 - 132250/(1+10%)^1 - 123625/(1+10%)^2
=230000 - 120227.30 - 102169.40
= 230000 - 222396.69
= 7603.31
APV = - 19676.82 + 7603.31
APV= -12073.51
Interest rate 10% Tax rate 25% Interest rate 23000 Tax Shield 5750 Effective Interest 17250 Loan installment 115000